Transfer Pricing and Cost-Plus for Israeli R&D Subsidiaries (2026)

The legal basis

Section 85A of the Israeli Income Tax Ordinance and the transfer pricing regulations require transactions between related parties to be priced at arm's length, consistent with the OECD guidelines. The Israeli company must keep documentation and file an annual declaration (Form 1385) with its corporate return listing its related-party transactions.

Larger groups also face master file and local file requirements and country-by-country reporting thresholds aligned with OECD BEPS Action 13.

How cost-plus works

• The subsidiary performs services for the parent: R&D, sales support, marketing or customer success.
• It charges the parent its relevant costs (salaries, rent, overheads) plus a markup.
• The markup is supported by a benchmarking study of comparable independent service companies.
• The subsidiary's taxable profit is the markup, taxed at 23% (or a reduced incentive rate if it qualifies).

Markups vary by function and benchmark; routine services often fall in a single-digit to low-teens percentage range, but the right figure for your entity comes from the study, not from a rule of thumb.

Which costs go into the base

The cost base usually includes salaries, social contributions, pension and severance funding, rent and operating expenses. Equity compensation is a frequent battleground: the Israeli Tax Authority has argued in court that the cost of employee stock options should be included in the cost base, increasing Israeli profit. Agreements should address this explicitly.

IP ownership: the high-stakes question

If the agreement says the parent owns all IP developed in Israel and bears the risk, the Israeli company is a low-risk service provider. If, in reality, key decisions and people sit in Israel, the Tax Authority may say the Israeli company owns valuable IP.

This matters most at exit or restructuring. Israeli courts have upheld large assessments where IP or functions were moved out of Israel after an acquisition, treating it as a sale of the business. Write the agreement before work starts and make sure reality matches it.

Annual compliance

• Intercompany agreement signed and updated.
• Benchmarking study refreshed periodically.
• Form 1385 filed with the corporate return.
• Local file prepared and ready to deliver on request (typically within a short deadline).

Incentives and cost-plus

Israeli R&D subsidiaries can sometimes qualify for Preferred Technology Enterprise benefits. Cost-plus entities rarely own qualifying IP income, so the benefit is often limited, but it is worth testing, particularly where the Israeli company develops IP it owns.